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Index

Investing in small caps – avoid the index trackers and go active

The growth in passive index investing has been driven by two fundamental facts:  lower management fees and better performance.

According to S&P’s annual SPIVA survey: “In 2018, apart from the Australian mid- and small-cap funds, the majority of Australian funds did not outperform their respective benchmarks and had worse relative performance than in 2017.” (our emphasis).

The higher cost of active management, combined with the inability of most managers to outperform the index, means that passive investing in large cap equities is generally a sound investment approach.

But notice the important caveat in the above quote:  apart from the Australian mid- and small-cap funds.

Small cap stocks can be terrific investments.  Unlike, say, a big-four bank or a large miner, a small cap stock can double, triple or even octuple in size and still be a good investment.  Small companies can be disruptors or invent new business models that sweep up new consumers and hoover up revenues.  PolyNovo (PVN), for example, has a market capitalisation 20x higher today than five years ago.  That’s never going to happen with a BHP or Westpac.

So why not just invest in a small cap index and buy all those winners?  The answer is that for every PolyNovo, there are a bunch of experiments that fail.  The small cap world is where the Darwinian survival-of-the-fittest competition takes place before companies graduate into the mid / large cap world.  Avoiding companies that aren’t going to make it and investing in those that might is how small cap managers have consistently beaten the index.

According to S&P, in the 5-year and 10-year periods to end 2016, 52% and 67% of Australian mid and small cap funds outperformed the S&P mid-small index, respectively.  This fell back a bit in 2017 but by the end of 2018 mid and small cap funds outperformed the index again.

eInvest is bringing active ETFs to market where active management makes sense.  Our Future Impacts Small Cap fund (IMPQ), uses both financial metrics and ESG scores to determine which small cap companies are most likely to grow and which ones to avoid.  Since inception in May 2019, the Fund has delivered a +3.8% p.a. return net of fees, outperforming by +3.7% p.a. the benchmark return of +0.1% p.a.

So to have a positive impact, both for your portfolio and society at large, put some IMPQ into your portfolio.

 

By Tamas Calderwood.

The Responsible Entity is Perennial Investment Management Limited ABN 13 108 747 637, AFSL: 275101. The Investment Manager is Perennial Value Management Limited ABN 22 090 879 904 AFSL: 247293. This promotional article has been prepared by ETF Investments Australia Pty Ltd trading as eInvest Australia (‘eInvest’) ABN: 88 618 802 912, as the corporate authorised representative of Perennial Investment Management Limited. This promotional article is for information purposes only. Accordingly, reliance should not be placed on this information as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs or financial situation. While every effort has been made to ensure the information is accurate; its accuracy, reliability or completeness is not guaranteed. Past performance is not a reliable indicator of future performance. You will be able to download the PDS from www.einvest.com.au